Dominance and Monopolization

Tilburg University

Dominance and Monopolization

Canoy, M.F.M.; Rey, P.; van Damme, E.E.C.

Publication date:

2004

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Citation for published version (APA):

Canoy, M. F. M., Rey, P., & van Damme, E. E. C. (2004). Dominance and Monopolization. (TILEC Discussion Paper; Vol. 2004-022). TILEC.

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TILEC Discussion Paper

Dominance and Monopolization

By

Marcel Canoy, Patrick Rey, Eric van Damme

DP 2004-022

Dominance and Monopolization

Marcel Canoy

∗

∗∗

∗∗∗

# _{Prepared for the International Handbook of Competition to be published with Edward Elgar,}

2004

∗ _{CPB Netherlands Bureau for Economic Policy Analysis, canoy@cpb.nl}

∗∗ _{IDEI, Universite Toulouse I, prey@cict.fr}

Contents

1 Dominance and competition policy 2 Regulation versus competition policy 3 Single-firm dominance and monopolization

3.1 Introduction

3.2 Abuse of a dominant position and monopolization 3.2.1 Strategies aimed at deterring entry

3.2.2 Strategies aimed at forcing the exit of a rival 3.2.3 Strategies aimed at raising rivals’ costs 3.3 Conclusion

4 Dominance through collusion

4.1 Relevant factors for tacit collusion 4.2 What can competition authorities do? 5 Dominance versus monopolization: a legal overview

5.1 The rules of the game

5.2 Dominance, monopoly and market power 5.3 Abuse and monopolization

6 Dominance versus substantial lessening of competition 6.1 Rules and procedures

6.2 Collective dominance

6.3 SLC or dominance: does it make a difference? 6.4 Efficiencies

7 Research agenda

1 Dominance and competition policy

Mixed feelings. A firm is in a dominant position if it has the ability to behave independently from its competitors. Dominant firms attract public attention and often arouse mixed feelings. Consumers enjoy branding when it makes life predictable, but grumble when the price of their favorite brand is raised. Policy makers may be proud of their Heinekens, Microsofts or McDonalds, but become unhappy if they restrict choices. Rivals of dominant firms might be lucky if the dominant firm is a toothless giant, but a predatory tiger scares them off.

Ambiguous welfare consequences. The mixed feelings can easily be explained. From a theoretical point of view, it is not clear whether dominant firms reduce or enhance welfare. There are many reasons for that. First, a dominant firm can be a successful innovator which is typically good for welfare. But it can also be a firm that emerged from an anti-competitive merger which is typically bad for welfare. Second, some ex post behavior may have adverse welfare consequences even when dominance stems from innovation. An innovator may engage in such abuses as predatory pricing that might well prevent or delay subsequent inno-vations. Third, when dominant firms engage in behavior that might reduce welfare (such as predatory pric-ing), how can such behavior be distinguished from normal efficiency enhancing business practices (such as stunting)? Fourth, welfare reductions today might be traded off against welfare gains tomorrow (or vice versa), and who is going to determine which generation goes first?

notably, treating agents as price takers is simply not on in any real life market, let alone in markets where dominance is an issue. So we leave Pareto and general equilibrium aside, and move towards partial equilib-rium analysis. The two most common welfare notions in industrial economics are consumer surplus and total surplus, i.e. the sum of consumer and producer surplus.

Consumer and producer surplus. Why would one look at consumer surplus rather than total surplus in welfare analysis? The dead weight loss argument is the most straightforward reason for looking at con-sumer surplus. In a simple monopoly setting, total welfare is maximized if concon-sumer surplus is maximized and price equals marginal cost. The reason is that maximizing consumer surplus implies minimizing the dead weight loss (see e.g. Tirole, 1988). Yet there are more complex settings in which the two welfare no-tions diverge. A too simplistic application of the dead weight loss argument results in ignoring dynamic considerations which are also important for consumers. Consumers appreciate innovation and product choice, but they are not part of dead weight loss triangles. How does this compare with the goals of competi-tion authorities?

The early goals of competition authorities in the US and Europe. It is not obvious that competition authorities (always) strive for maximization of (consumer) welfare. In the US, antitrust policy was a reaction to the formation of trusts that concentrated economic power. Small firms and farmers complained about the economic power of these trusts and lobbied for protection.

of the main goals of their competition law. A strict interpretation of maintaining freedom of action would conflict with the efficiency goal.

In the European Union, competition policy is an instrument to achieve the goals of the Community: (roughly) the creation of a single market area with a high standard of living for all those that live in it. Con-sequently, two goals are usually distinguished: market integration and economic efficiency. Note that these two goals may conflict: market integration, when interpreted as the prohibition of price discrimination across countries, may go at the expense of economic efficiency.

Conflicting goals of competition law. From above it followed that there are various potential goals of competition law and that some goals can conflict. Two cases that are interesting in this respect are UK Distillers and Ford/Volkswagen. In UK Distillers, the Commission was upset by price discrimination by the Distillers Company for Whisky between France and the UK. When ordered to end the practice, the company simply stopped supplying the French market, leaving prices in UK unchanged. In Ford/Volkswagen, the Commission allowed a joint venture of these two car makers to produce MPVs (Volkswagen Sharan and Ford Galaxy) in Portugal, with the argument that this created jobs in Portugal and would lead to better inte-gration of Portugal in the Community.

Within the public interest domain, one may distinguish several objectives for competition policy:

(i) Maintaining competition

(ii) Maintaining economic freedom

(iii) Achieving market integration

(iv) Maximizing total welfare

It is difficult to argue what the goal of a competition authority should be, although one may say that compe-tition policy is guided by the objectives mentioned above. In the European Union, Article 81 EU Treaty of the Maastricht Treaty reveals an underlying ambiguity. Article 81 EU Treaty(1) prohibits all agreements between firms that restrict competition, but Article 81 EU Treaty(3) exempts from the prohibition agree-ments that are efficiency-enhancing, provided that consumers get a fair share of the resulting benefits. Hence, in Article 81 EU Treaty(1), the goals (i) and (ii) feature (some even identify a restriction of competi-tion with a restriccompeti-tion of freedom of accompeti-tion), while in Article 81 EU Treaty(3) both goals, (iv) and (v), fea-ture. Therefore, we can conclude that a criticism of a competition authority’s decision would be justified only if that decision cannot be justified by any reasonable combination of the above criteria that could be adopted by the competition authority.

One may argue that consumer welfare should be the goal of competition policy. For example, Robert Bork (1978, p. 405) has stated "The only goal that should guide interpretation of the antitrust laws is the welfare of consumers". What can be inferred from official documents?

In the UK, the Office of Fair Trading’s (OFT) mission is to: "to protect consumers and explain their rights" and "to ensure that businesses compete and operate fairly".1

The European Commission (2000, p. 4) puts it slightly differently: "The Community’s competition policy pursues a precise goal, which is to defend and develop effective competition in the common market. Compe-tition is a basic mechanism of the market economy involving supply (producers, traders) and demand (in-termediate customers, consumers). Suppliers offer goods or services on the market in an endeavor to meet demand. Demand seeks the best ratio between quality and price for the products it requires. The most effi-cient response emerges as a result of a contest between suppliers. Thus, competition leads everybody

vidually to seek out the means of striking this balance between quality and price in order to meet demand to the best possible extent.

Competition is therefore a simple and efficient means of guaranteeing consumers a level of excellence in terms of the quality and price of products and services. It also forces firms to strive for competitiveness and economic efficiency. This consolidates the Community’s industrial and commercial fabric so that it is able to confront the competitiveness of our main partners and to put Community firms in a position to succeed in markets around the world."

The US Federal Trade Commission, finally, puts it as follows:2 "[Competition] enforces a variety of federal antitrust and consumer protection laws. The Commission seeks to ensure that the nation's markets function competitively, and are vigorous, efficient, and free of undue restrictions. The Commission also works to enhance the smooth operation of the marketplace by eliminating acts or practices that are unfair or decep-tive. In general, the Commission's efforts are directed toward stopping actions that threaten consumers' op-portunities to exercise informed choice. … In addition to carrying out its statutory enforcement responsibili-ties, the Commission advances the policies underlying Congressional mandates through cost-effective non-enforcement activities, such as consumer education."

Reconciling consumer and total surplus. The common element is that (apart from possible other goals) competition authorities protect consumers and assume that vigorous competition is the right tool of getting good deals for consumers. In theory it is possible to reconcile total surplus and consumer surplus. Consumer surplus in the long run comes closer to total surplus than just consumer surplus in the short run. Maximizing consumer surplus in the long-run must involve producer surplus. Profits are necessary for in-vestment and innovation, and are therefore also ingredients of consumer benefits in the long run. Of course, this is no hard evidence in favor of consumer surplus and nuancing is needed. Consumer surplus is only a

reasonable approximation of welfare if long run effects are taken into account. It is not automatic that com-petition authorities do this.

Empirical evidence of concentration. The attention that scholars and policy makers dedicate to mo-nopolies, oligopolies and dominant firms suggests that there are indeed lots of dominant firms around. It is not feasible (at least not at this moment) to test "dominance" per se, but given the (statistical) correlation between size (market shares) and dominance, we use concentration tendencies as a rough approximation for dominance. This exercise is not to test a certain hypothesis, but to get a feeling for numbers and trends.

We start with a discussion of the older evidence. The international commodity market is dominated by a few multinational corporations (Cowling, 2002). Concentrated industries tend to be more profitable, also in the long run (Mueller, 1986). Of more recent significance is the concentration in the services industries, such as banking, communications, IT and media. In the USA, in 1985, there were 14,600 commercial banks. The 50 largest banks owned 45.7 of all assets, the 100 largest held 57.4%. In 1984 there were 272,037 active corpo-rations in the manufacturing sector, 710 of them held 80.2 percent of total assets. In the service sector 95 firms of the total of 899,369 owned 28 percent of the sector’s assets. In 1986 in agriculture, 29,000 large farms (1.3% of all farms) accounted for one-third of total farm sales and 46% of farm profits. In 1987, the top 50 firms accounted for 54.4% of the total sales of the Fortune 500 largest industrial companies. (Du Boff, 1989, p. 171).

firms account for over 85 percent of the output of beef, while the other 1,245 firms have less than 15 percent of the market.

Another fact is that large companies tend to become more diversified as the concentration levels in individ-ual industries increase. Tobacco companies are the masters of diversification. Jell-O products, Kool-Aid, Log Cabin syrup, Minute Rice, Miller beer, Oreos, Velveeta and Maxwell House coffee are all brands owned by Tobacco companies.

More recent evidence points in the same direction. Many European and US markets have been consolidating in a rapid fashion. Yet, most mergers tend to be unhappy marriages.3 Does that mean that the large firms destroy welfare?

Whether concentrations are as bad as some people believe is unclear. The mere fact that the merged parties are, on average, unhappy ex post, does not mean welfare is reduced, since the source of unhappiness is un-known. Perhaps they are unhappy because competitors reacted more fiercely than anticipated. Perhaps wel-fare was reduced for the merged parties but not for their competitors or for the consumers. A priori, the ten-dencies can equally likely point at increased possibilities of exploiting scale and scope economies as at in-creased abuses of market power. It is the duty of competition authorities to make up their mind which of the two prevails.

Persistence of dominance. We observe that oligopolies and (near) monopolies occupy large and important parts of the economy. Yet, there seems to be a widespread presumption among economists that dominant firms have a tendency to decline. It is important to check in how far this presumption is right, since rapidly declining dominant firms obviously affect optimal policy responses. Mueller (1986) and

Geroski (1987) in seminal contributions have actually tested this hypothesis empirically.4 Checking the ac-tual decline of market leaders in the U.K. and the U.S., Geroski finds no evidence of acac-tual decline, defined as some mix of incumbent’s erosion of profits and market shares over time. For example, based on market shares result of the 108 observed dominant firms, 32 did not decline, between 46 and 51 declined 6 percent or less (Geroski). However difficult these results are to be interpreted, it shows that there is nothing like a systematic rapid decline of dominant firms. Mueller (1986) studied the largest 1000 firms in the US in the period 1950-72 and concluded that the typical firm with persistently high earnings has a large market share and sells differentiated products.

Lacking stronger evidence, we will employ the working hypothesis in this chapter that alert dominant firms, when left untouched by competition authorities, have enough possibilities to maintain their position, at least in a non-trivial number of cases.

Policy responses towards dominance: two polar views. Most of what we have discussed so far is not altogether controversial. Yet when we will discuss policy responses to dominant firm behavior, there is more room for controversy. We distinguish two polar views. At one side of the spectrum is what we call the "Schumpeter-visits-Chicago position". This position takes a relaxed view towards dominant firms, arguing that dominant firms are in general good for consumers, create lots of jobs, innovate, and exploit scale economies. It typically downplays potential adverse effects of dominant firms, suggesting that the adverse effects are temporary and cannot be detected at socially acceptable costs anyhow. In the words of Schmalen-see (1987, p. 351):5

4 _{See also Geroski and Jacquemin (1988) for a European cross-country study, the}

country-specific studies in Mueller (1990) as well as Odagiri and Maruyama (2002) for a recent study on Japa-nese manufacturing.

"Firms may achieve short-run dominance through merger or other actions that are not directly productive. But most dominant positions, particularly those created in the US after ‘merger to monopoly’ was ruled illegal in 1903, have their origins to an important extent in innovation, broadly defined. Firms that attain short-run dominance by merger or other means but have no advantages over actual and potential rivals and are badly managed tend to perform poorly and lose dominance in a matter of years. In other cases, dominant positions may take many decades to decay appreciably."

It comes as no surprise that the "Schumpeter-visits-Chicago" position also particularly worries about possi-ble adverse effects of government intervention. The favorite quote is "The successful competitor, having been urged to compete, must not be turned upon when he wins" (Judge Hand in the Alcoa decision).6

At the other side of the spectrum is what some might be tempted to baptize "Old Europe". Here the aim is to "chase the villains". It finds supporters among a number of regulators, competition authorities, politicians, anti-globalists and some academic scholars. In the words of Cowling (2002):7

"We can conclude at this point that oligopolistic structures generally prevail at some stage of the global pro-duction process: obviously, myriad small propro-duction units exist, but they exist within a system dominated by relatively few giants. The implication is that we can expect a general divergence of prices from the competi-tive level. We shall now assess theoretical grounds and empirical evidence for the significance of this diver-gence, the factors underlying it and the consequences for profits, and thus for the broad distribution of in-come between capital and labor."

At this side of the spectrum there is less worry about dynamic features and government failure. The favorite quotes here are from the Michelin case (57/1983) "a finding that an undertaking has a dominant position is not in itself a recrimination but simply means that, irrespective of the reasons for which it has such a

nant position, the undertaking concerned has a special responsibility not to allow its conduct to impair genu-ine undistorted competition on the common market" and Hicks’s "The best of all monopoly profits is a quiet life" (1935, p. 8).

Type I versus type II errors. Differences between the two polar views can be explained by different weights that are attached to type I and type II errors. With Judge Hand’s Alcoa quote in mind, it is not sur-prising that the Schumpeter-visits-Chicago-position dislikes unjust convictions of innocent firms. This paral-lels American cultural habits of rewarding winners and ignoring losers. Equally so, Old Europeans tend to protect the poor and weak, and henceforth put more weight on type II errors. Both polar views seem to have some good arguments and some bad ones. Available empirical evidence also produces a mixed ball.

Combining insights from both polar views. Most economists would adopt arguments from both sides and we are no exceptions. First we see no reason to take a relaxed attitude towards dominant firms. There are robust economic theories showing that dominant firms have all the incentive and ample possibilities to reduce welfare, however measured. There is no indication that dominant firms spontaneously fall apart (Mueller, Geroski) nor are there convincing arguments that (persistent) dominance is required to innovate.8 Dominant firms also produce the large bulk of the economy and occupy positions in vital sectors of the soci-ety such as telecom, banks, electricity, transport and so forth. This means that underperformance of domi-nant firms may also have adverse non-economic effects. So these are useful Old Europe arguments. Yet, dominant firms are often firms that heavily invest in infrastructure, assets or innovation. A government that decides to intervene in this type of market should be aware of the potential consequences of intervention, in

7 _{Cowling is in fact more moderate than the polar position suggests.}

8 _{Reviewing the literature on competition and innovation, Bennett, De Bijl and Canoy (2002)}

particular, of the consequences of making mistakes. As Fisher (1991, p. 201) has put it in the context of monopolies:

"Economists and others ought to approach the public policy problems involved in these areas with a certain humility. Real industries tend to be very complicated. One ought not to tinker with a well-performing indus-try on the basis of simplistic judgments. The diagnosis of the monopoly disease is sufficiently difficult that one ought not to proceed to surgery without thorough examination of the patient and a thorough understand-ing of the medical principles involved."

A mistake in a market with a lot of dynamics and big stakes is not only more consequential, also the prob-ability that a mistake is made is larger than in other markets. A lot of dynamics implies more uncertainty, therefore a higher probability of mistakes. Also, the need for intervention reduces when markets tomorrow will look different from markets today. As a consequence of this, government intervention should be propor-tionate to the problem, no more and no less.

collective dominance cases and the like. In terms of type I and type II mistakes: In the legal history in the Western world it is commonplace to only convict criminals if their guilt is proven beyond reasonable doubt. This puts all the eggs in the type I basket. The reason is by and large normative in nature: as explained above, it is felt that only serious cases should go to court. For less clear-cut cases other instruments are eas-ier to use. Policy makers have much more leeway than judges to do what they think is best. Whether this leeway is always used in a welfare enhancing way is of course a different matter.

This chapter further elaborates on the welfare consequences of dominance and monopolization and possible policy responses to that. Section 2 delves deeper into the two major policy responses towards dominance, regulation and antitrust. Section 3 then introduces single-firm dominance and different types of abuses of dominance. Section 4 discusses collective (or, group) dominance. Section 5 compares legal approaches in the US and Europe towards dominance and monopolization. Section 6 does the same with mergers. Section 7 concludes.

2 Regulation versus competition

Dominant firms are exposed to various types of supervision. In some cases, as for example in the telecom-munications industry, they are subject to rather detailed, industry-specific regulation. In other cases, they are only subject to general antitrust supervision. It is therefore useful to start this chapter with a brief compari-son of "regulation" and "antitrust"; several dimensions are relevant in this respect: timing of oversight, pro-cedures and control rights, information and continued relationship.

however, since for example merger control often requires notification for large mergers and is a quasi-regulatory process.9

Relatedly, ex ante supervision must be more expedient. The necessity not to halt productive decisions often puts pressure on regulators and merger control authorities to converge on rapid decisions. In contrast, the ex post nature of antitrust intervention does not call for a similar expediency – except maybe for predatory cases, where interim provisions may be necessary to prevent irreversible damages.10

The uncertainty about the overseer’s decision making differs between the two institutions. Ex ante interven-tion removes most of the uncertainty about this interveninterven-tion (although not necessarily about its conse-quences); it may thus facilitate financing of new investment by alleviating the lender’s potential informa-tional handicap with respect to this intervention and by sharpening the measurement of the firm’s perform-ance.

Ex ante intervention also improves the supervisor’s commitment toward the firm. This commitment is desir-able whenever the industry supervisor has the incentives and the opportunity to exploit the firm’s efficiency or investment. To be sure, competition authorities can publish guidelines to pre-announce their policy. How-ever, these guidelines may still leave some scope for interpretation, and moreover they need not be followed by the courts.

9 _{See Neven et al. (1993) for a relevant discussion of institutions in the context of merger}

con-trol. In the E.U., inter-firm agreements that would fall under Article 81 EU Treaty must also be notified in order to benefit from an exemption; however, following a recent reform, these agreements will be dealt with "ex post" from Spring 2004 on. Berges-Sennou et al. (2001) formally compare the prior noti-fication regime with the ex post audit regime and stress that the balance tilts in favor of the latter as the competition agency’s scrutiny becomes more precise.

10 _{In particular, ex post intervention may serve as a deterrent but come too late to act as a}

Finally, ex ante intervention may force the firm to disclose information that it would not disclose ex post. It is indeed often less risky for the firm to conceal or manipulate information ex post than ex ante; for instance, the firm may know ex post that a lie about an information that conditioned some business decision will not be discovered, but it may have no such certainty ex ante. Relatedly, an ex ante regulator can ask the firm to collect and organize information in a given way; getting specific information ex post may prove difficult if it is not planned for in advance.

A drawback of ex ante intervention is that it may foster collusion between the industry and the supervisor. The industry knows whom it is facing while it is much more uncertain about whether it will be able to cap-ture the (unknown) overseer in a context in which the oversight takes place ex post. This uncertainty about the possibility of capture increases the firm’s cost of misbehaving.

A second benefit of ex post intervention is of course the opportunity to take advantage of information that arrives "after the fact". For example, it may over time become clearer what constitutes acceptable conduct. To be certain, ex ante decisions could in principle allow for ex post adjustments that embody the new infor-mation; but describing properly ex ante the information that will determine acceptability may be prohibi-tively difficult.

Procedures and control rights. While antitrust authorities usually only assess the lawfulness of duct, regulators have more extensive powers and engage in detailed regulation; they may set or put con-straints on wholesale and retail prices, determine the extent of profit sharing between the firm and its cus-tomers (as under cost-of-service regulation or earnings-sharing schemes), oversee investment decisions, and control entry into segments through licensing for new entrants and line-of-business restrictions for incum-bents.11

11 _{For example, in the US the Federal Communications Commission has imposed price caps to}

Regulators’ discretionary power is of course qualified by the many constraints they face in their decision making: procedural requirements, lack of long-term commitment, safeguards against regulatory takings, constraints on price fixing or cost reimbursement rules (of-service regulation, price caps, etc.), cost-based determination of access prices, and so forth.

Conversely, antitrust authorities and courts sometimes exercise regulatory authority by imposing line-of-business restrictions or forcing cost-of-service determination of access prices. A case in point is Judge Greene becoming a "regulator" of the American telecommunications industry. In Europe, where there has been a growing interest in essential facility and market access issues, the European Commission has tried to develop both antitrust and regulatory competences and methods.

There is some convergence of regulatory and competition policy procedures. For example in the US, regula-tory hearings are quasi-judicial processes in which a wide array of interested parties can expose their view-points. The enlisting of "advocates" is prominent in both institutions and contributes to reduce the informa-tional handicap of the industry overseer.12

There are also a couple of differences, however. Private parties tend to play a bigger role in antitrust en-forcement than in a regulatory process – indeed, while competition authorities occasionally conduct inde-pendent industry studies, the vast majority of cases are brought forward by private parties. Another differ-ence is that interest groups are motivated to intervene in the regulatory process solely by the prospect of modifying policy while they complain to competition authorities or courts either to modify industry conduct (through an injunction) or to obtain monetary compensation (e.g., treble damages in the US). Yet another difference comes from the fact that competition authorities have less control over the agenda than regulators

excessive prices could constitute an abuse of a dominant position under Article 82 EU Treaty, but so far the European Commission has rarely used this possibility.

– the activities of courts and, to a lesser extent, competition authorities are somewhat conditioned by the cases put forward.

Another distinction between the two institutions is the possible separation between investigation and prose-cution in antitrust. Regulators conduct regulatory hearings and adjudicate on their basis, while at least in some countries competition authorities may have to win their case in court.13 For example, in the US the decisions of the Federal Communications Commission (FCC) take directly effect (except if appealed); in contrast, the Antitrust Division of the Department of Justice must not only go to court but it moreover bears the initial burden of proof. Regulatory decisions may however be appealed in court, in the same way a court decision may be overruled by a higher court.14

Eventually, while regulators and competition authorities are both required to apply consistent reasoning, regulators are mainly bound to be somewhat consistent with their previous decisions for the industry they oversee. In contrast, competition authorities and courts must also refer to decisions pertaining to other indus-tries – and, moreover, in common law systems, they must take into account other court decisions.15

Information and expertise. Regulatory decisions tend to rely on superior expertise. While antitrust enforcers have a fairly universal mandate, regulatory agencies usually specialize on a specific industry on a

13 _{This is for example the case in the US; in contrast, in the EU the European Commission both}

investigates and decides. It is however currently devising ways to disentangle these two aspects, in the line of what has been adopted in European countries such as France, where the Competition Council – a jurisdictional entity with decision powers – has different bodies in charge of investigations and deci-sions.

14 _{In the case of the FCC, however, federal courts limit themselves to ensuring only that the}

Commission acts in a "reasonable" manner and does not engage in "arbitrary and capricious" behavior. In contrast, the Antitrust Division is not entitled to substantial deference.

15 _{The interaction between the two sets of case law is also interesting. The new European}

long-term basis. In addition, regulators usually have larger staffs and monitor the firms’ accounts on a con-tinuous basis rather than on an occasional one; they can also insist on specific accounting principles (such as accounting separation) as well as disclosure rules.

Superior expertise allows better informed decision making. For example, regulators may use cost-based rules for retail and wholesale prices in spite of the difficulty in assessing costs, while antitrust enforcers are more at ease with cases based on qualitative evidence (price discrimination, price fixing, vertical restraints, …) than with cases that require quantitative evidence (predation, tacit collusion, access pricing, …).

Superior expertise may however be a handicap when regulators have limited commitment powers. When a firm invests to improve its technology, regulators (or politicians) may wish to confiscate the efficiency gains – e.g., through lower prices. The regulator’s access to information exacerbates this "ratchet effect", which impedes efficiency. Similarly, an excessive attention may inhibit the firm’s initiative. In contrast, an arm’s length relationship may entail more commitment power and help provide better incentives.16

The regulatory agencies’ expertise stems in part from its long-term relationship with the industry. But, as is well-known, long-term relationships are, in any organization, conducive to collusion. In addition, the need for industry-focused expertise imposes constraints on the recruitment of regulators, and natural career evolu-tions are more likely to involve close links with this industry; as a result, the regulators’ expertise may rein-force "revolving doors" problems.

This brief overview of the analogies and differences involved in the two types of supervision suggests that antitrust supervision by a "generalist" competition agency is best suited when detailed regulation is not cru-cial; in contrast, oversight by an industry-specific regulatory agency may be warranted when detailed ex ante regulation is needed, as it may for example be the case for access policies.

We now turn to competition policy towards single and collective dominance.

3 Single-firm dominance and monopolization

3.1 Introduction

Background. Throughout the world, competition authorities ask the question: How do firms with (substantial) market power behave? Or more specifically: How can firms with (substantial) market power exploit this power? The economic literature can help answering these questions. Indeed, for decades mo-nopolies and oligopolies have filled economic textbooks and governments have longstanding traditions in using these theories to design policy responses to counter adverse effects of powerful firms. Yet, real-life markets do not always behave according to textbook predictions. Assessing monopolistic and oligopolistic behavior is complex and cannot be solely based on textbook predictions.

Over the last decade an increasing number of scholars stressed the importance of finding a neat balance be-tween unfettered competition and intervention. As explained in the introduction, the laissez-fair Schum-peter-visits-Chicago view stresses the importance of free markets and innovation while the Old Europe view points at what can go wrong in free markets. Using arguments from both sides, it is perhaps best to scruti-nize abuses of a dominant position while realizing the potential downsides of government intervention. Against this background, this section describes what market power amounts to, and how firms can abuse market power.

Definition of single-firm dominance. According to the European Commission official documents dominance is defined as follows:17

"A firm is in a dominant position if it has the ability to behave independently of its competitors, customers, suppliers and, ultimately, the final consumer."

The crucial part in this definition is "to behave independently". By behaving independently firms can mimic monopoly behavior and thereby reduce welfare:

"A dominant firm holding such market power would have the ability to set prices above the competitive level, to sell products of an inferior quality or to reduce its rate of innovation below the level that would exist in a competitive market."

Crucial here is to "have the ability". A dominant position is thus a status not an action:

"Under EU competition law, it is not illegal to hold a dominant position, since a dominant position can be obtained by legitimate means of competition, for example, by inventing and selling a better product. Instead, competition rules do not allow companies to abuse their dominant position. The European merger control system differs from this principle, in so far as it prohibits merged entities from obtaining or strengthening a dominant position by way of the merger."

To punish a dominant firm, one has to show that the firm actually exploits "the ability to behave independ-ently of its competitors ...". To show that the probability of abuse after a merger has increased significantly creates a high burden of proof for merger analysis, which is by nature ex-ante. That is why it is sufficient to show that a dominant position is sufficiently likely to emerge after a merger.

motivation, the legal practice developed more and more in the direction of the "efficiency doctrine", e.g., judges are unhappy to block a merger just to protect some small player in the market.

The general approach in the US is to outlaw monopolization, attempts to monopolize or conspiracies to mo-nopolize. Similar to the dominance doctrine it requires firms to have market power. Many practices can be illegal (e.g. sabotage, mergers, refusal to deal, tying, price discrimination, raising rival’s cost etc), but all of them require firms to have "sufficient market power". Since an appropriate definition of market power is "the power to raise prices above the competitive level without losing so many sales that the price increase is unprofitable"18, having "sufficient market power" is very similar to dominance. So we conclude that the general approach towards monopolization is not fundamentally different on both sides of the ocean. That is not to say that there are no important differences, though.

The US approach is aimed at preventing monopoly situations. It is less worried about actual behavior, once a monopoly has been established. By contrast, the European approach forbids various types of conduct by dominant firms. More detailed differences will be addressed shortly as well as in Section 5.

Economic models of single firm dominance I: monopoly. There are basically two different economic models underlying single firm dominance. The first one is the most straightforward one: the monopoly model. A monopolist obviously "has the ability to behave independently of its competitors, customers, sup-pliers and, ultimately, the final consumer". It is well-known that monopolies have an incentive to raise price above the competitive level, at the expense of consumers, that is, giving rise to a dead weight loss. Indeed, in the most straightforward textbook model, monopolies have an incentive to produce less than is socially de-sirable. There are also more subtle ways in which welfare can be reduced by monopolists, such as rent-seeking, lack of innovation incentives, X-inefficiencies and suboptimal product selection. These suboptimal

effects need not occur. Counterforces include the exploitation of scale economies, the threat of potential entry, commitment problems19 and innovation.

Which of these forces prevail is hard to say. Even in concrete cases such as the Microsoft case economists tend to disagree on the appropriate economic model and the welfare consequences. Nevertheless, some gen-eral conclusions can be drawn.

Monopolies tend to select suboptimal levels of output and price in markets characterized by relatively modest scale economies, lack of fast innovation and entry barriers.

Even in the presence of counter forces, such as innovation, monopolies can still reduce welfare.

Even if monopolies do reduce welfare, it is neither straightforward nor costless to counteract such mo-nopoly behavior.

Whether counterforces do outweigh the welfare losses associated with monopolies, is context depend-ent.

parently behaves as a monopolist. The fact that the market structure looks more like an oligopoly than a monopoly seems irrelevant. However, this observation denies the importance of strategic interactions.

What does it mean, in the context of an oligopoly, to behave "independently" of its competitors? Section 3.2 provides economic examples of (abuse of) independent behavior, such as predation and foreclosure. These examples are characterized by the fact that a single firm punishes a (potential) competitor. It can only prof-itably do so if it faces relatively little competition. Competitive forces will make (anti-competitive) price discrimination unattractive, which will prevent predation as well as foreclosure. This does not mean that the monopoly model applies. Oligopoly theory teaches us how firms interact strategically (see, e.g., Tirole, 1988). A dominant firm that attempts to eliminate a rival by predatory pricing has to predict both, how the prey will react to the pricing, as well as likely responses by future rivals. Hence strategic interaction and oligopoly theory are as vital for understanding single-firm dominance as monopoly theory.

The use of oligopoly models becomes clear when studying attempts to deter entry. Firms with market power who want to deter entry have to play a strategic oligopoly game with (potential) rivals. The outcome of such a game determines whether deterring entry is a profitable strategy. The outcome of the game is influenced by the parameters of the game. In a stylized two-period, two-firm model the incumbent firm chooses some variable X (e.g. capacity) in period 1. Firm 2 (the potential entrant) observes X and decides to enter or not. In period 2 some strategic variable (e.g. price) is set. The parameters that influence the Nash equilibrium of such a game are: whether the strategies are substitutes (quantities) or complements (prices), the level of asymmetry, the level of product differentiation, the switching costs etc.20 So what appears to be "monopoly behavior" could easily be sustained as a Nash equilibrium in an oligopoly game. It becomes clear that oli-gopoly models are vital tools for understanding incentives by powerful firms to deter entry. The same ap-plies for other types of behavior such as raising rival’s costs or predation (see further subsection 3.2).

There is also another important category of so-called "independent behavior". It is best explained in the con-text of a potential merger in a Cournot type setting. First in the words of the Commission:

"Under certain circumstances, a merger weakens competition by removing important competitive constraints on one or more sellers, who consequently find it profitable to increase prices or reduce output post merger. The most direct effect will be the elimination of the competitive constraints that the merging firms exerted on each other. Before the merger, the merging parties may have exercised a competitive constraint on each other. If one of the merging firms had raised its price or reduced then it would have lost customers to the other merging firm, making it unprofitable. The merger would thus eliminate this particular constraint. In addition, non-merging firms can also benefit from the reduction of competitive pressure that results from the merger since the merging firms price increase or output reduction may switch some demand to the rival firms, which, in turn, may find it optimal to increase prices. The elimination of these competitive constraints could lead to a significant price increase or output reduction in the relevant market."21

Put differently: if there are four players playing Cournot, a merger between two of them will ceteris paribus reduce output and increase price. It is questionable whether this particular interpretation of "independent behavior" should fall under the heading of dominance. In economic terms this type of oligopoly behavior can hardly be called "independent" since it depends inter alia on conjectures on behavior of other players. It is also not related to market shares. The same arguments can be used whether or not we are facing a 50-20-15-15 split of the market or a 25-25-25-25 split.

It is noteworthy that the Cournot type unilateral effects in oligopolies mentioned above are not part of the "old" dominance definition in Article 82 EU Treaty cases. For the purposes of this Chapter, we prefer to keep the old definition of single-firm dominance (with a possible exception to mergers), i.e. interpreting "independent behavior" in a rather strict sense, i.e. excluding Cournot type behavior.

Concluding, the monopoly model is important for its focus on behavior by a firm that faces little (or no) competition. The oligopoly model is important for its focus on strategic interaction. Even if a firm faces little competition, its behavior can easily be based on strategic motives, e.g. attempts to deter entry.

What makes a firm "dominant"?. As it is not clear a priori under which circumstances firms are able to "behave independently", there is need for further clarification. The most common legal tool to test whether or not a firm is dominant is the market share test. If a firm has a 40-50% market share, then a firm is assumed to have sufficient market power to be called dominant. While being practical, measurable and le-gally accepted, from an economic perspective the market share test is too simplistic for two reasons. First, even large players need not be dominant. In the case where innovation is taking place at a rapid pace, in the case of fierce competition between large players, or strong disciplining by potential entrants, firms cannot "behave independently". Second, there can be cases where firms have lower shares, say 25%, but are still dominant. This can occur if entry barriers are high and market power is reflected through other channels than just market share. Arguably, such cases are statistically less significant22, but should not be neglected.

The arguably most extreme position towards market power was taken by Judge Wyzanski in United Sates v. United Shoe Machinery Corp (1953).23 He claimed that a firm with sufficient market power monopolizes "whenever it does business". This position has not been followed on either side of the Atlantic Ocean.24 Instead, firms have to be in a dominant position and abuse the position. Why is this needed? There are basi-cally two reasons. First, a firm can owe its dominant position to superior past performance, e.g., in the form of an innovation. The sheer fact that a firm is in such a position does not seem to be worrying and does not

22 _{The bulk of empirical evidence reveals that one is most likely to find dominant firms under the}

larger ones (see, e.g., Scherer and Ross, 1990, Church and Ware, 2000).

23 _{110 F.Supp. 295 (D. Mass. 1953)}

24 _{Except, of course, in merger cases where the creation of dominance is enough to block a}

warrant intervention. Second, in the case of a natural monopoly, it is cost inefficient to have more players in the market, so it is hard to see the justification of punishing efficiency.

Sliding scale. To cater to the various degrees of market power, legal practice in the US has devel-oped a difference between "a lot of market power" and "a smaller amount of market power". If the evidence suggests substantial market power then the courts have identified a certain set of practices that will condemn the defendant of illegal monopolization. If the evidence suggests lesser market power, then the courts tend to go for "attempt to monopolize" which carries stricter conduct requirements (cf. Hovenkamp, 1999). In Europe, such a "sliding scale" of market power does not exist, at least not in a legally formal way. In the US, (sufficient) market power and abuse of market power are not treated separately. In Europe, however, there is a rather strict distinction between dominance and abuse of dominance. The advantage of the European ap-proach is that it starts with a "dominance test", which is relatively straightforward compared to abuse. If there is no dominance, there is no case. This simple rule creates clarity for firms within a relatively short time period. The disadvantage is that it creates a somewhat artificial split between a "problem" area and a "no-problem" area, largely based on a market share criterion.25

Dominance and abuse. From economic theory we know however that there is not such a clear-cut split. It is not so difficult to envisage a heterogeneous goods market with high switching costs, minor inno-vative activity and large reputation effects, to fail the dominance test, but yet being potentially problematic, in a welfare sense.26 At the other end of the spectrum, firms that are labeled "dominant", face the restriction that certain types of behavior are almost per se forbidden. These types of behavior are not related to the se-riousness of the effects of possible abuse, i.e., certain behavior that might be abusive is forbidden in a

25 _{In practice, the discussion is not as black-and-white as suggested here. Antitrust authorities do}

look at other issues as well.

26 _{It is not clear though whether the competition law is the best way to deal with these types of}

haps too mechanistic way. As a consequence, if there are competition authorities or regulators who have a tendency to over-regulate, labeling a firm as dominant gives opportunities to impose unnecessary restric-tions.

The integrated approach in the US gives more possibilities for taking the seriousness of effects into account. Yet, the U.S., in a response to fears that expansive applications of antitrust may reduce innovation, becomes more and more reluctant to pursue monopolization cases. It is also a bit odd to be strict on preventing mo-nopolization (under the assumption that monopolies are bad) and yet be relaxed about actual monopolies.

Concluding, the current EU system, while being practical, bears a risk of running into type I and II errors, i.e. some dominant firms may escape the attention while some welfare enhancing behavior by dominant firms may be punished. The US system is not likely to produce many type I errors, but may be too lenient towards monopolization practices.27

A way forward? Let us discuss an option that might improve the European situation. There are two problems. The first is that the dominance test relies too much on market shares. The second one is that pos-sible abusive behavior is treated too mechanistically. A way to solve the first problem is to put more eco-nomics into the dominance test, which implies that less weight is put on market shares and more on other economic variables, in particular entry barriers. Competition authorities can have dominance cases with lower markets shares but high entry barriers and other problems. On the other side, market players with high market shares (say 60% or so) will have the opportunity to argue why they are not dominant despite their high market share. The disadvantage of that approach is that it is less predictable and that it may take more time.

To tackle the second problem, also more economics should be put into the abuse of dominance. When a firm is labeled dominant, more economic analysis is needed to underpin a ban on certain types of behavior (see subsection 3.2). The reason is that many types of behavior that can be called abusive have plausible welfare enhancing interpretations as well. Think of price discrimination. It is not clear a priori whether or not price discrimination by a dominant firm is good or bad. A recent case in Europe, Virgin /British Airways, clarifies this point. In 1998, Virgin complained against British Airways’s Performance Reward scheme (PRS) as in-fringing on Article 82 EU Treaty. The Commission criticized the PRS scheme for travel agents as “being abusive of a dominant position" (IV/D-2/34.780, p. 12). While the Commission analyzed the scheme in length, it did not make an explicit attempt to show that the scheme was actually anti-competitive and that the effects were welfare reducing.

Putting more economics into the dominance test without doing the same with abuse, runs the risk of over-regulation. Applying more economics in both areas creates a better balance between market and government failure so that type I and type II errors will be reduced.

3.2 Abuse of a dominant position and monopolization

As explained in section 2, for merger cases it is sufficient to demonstrate that a merger creates or strength-ens a dominant position. For Article 82 EU Treaty cases it is not sufficient to demonstrate that a firm has a dominant position. In the words of the EC, abuse of a dominant position is defined as:

Treaty lists some examples of abuse, namely unfair pricing, restriction of production output and imposing discriminatory or unnecessary terms in dealings with trading partners."28

The US has a list in similar vein (sabotage, mergers, refusal to deal, tying, price discrimination, raising ri-val’s cost etc). This section tries to shed some economic light on a number of these potential abuses.

Firms with a dominant position can employ a wide range of strategies that fall under the heading of abuse. The strategies can be grouped in three categories.

(i) Strategies aimed at deterring entry. The most common examples are strategic barriers, such as preemptive and retaliatory action by incumbents, e.g. strategic price discounts, excess ca-pacity and advertising.

(ii) Strategies aimed at forcing exit of a rival. Most studies examples of pushing a rival out are foreclosure and predation.

(iii) Strategies aimed at raising rival’s costs. Think e.g. of exclusive deals. Notice that the last two sets of strategies can also deter entry in addition to harming rivals.

There is a large literature on each group of strategies, including some general purpose articles such as Or-dover and Saloner (1989). While much that has been said in OrOr-dover and Saloner is still valid today, there are also a number of new developments in various areas. This section will focus on some of these new de-velopments.

Before we do that, we reiterate that each of the strategies discussed is not an automatic abuse, or should not be an automatic abuse. Price cutting, advertising, vertical relationships etc are all part of normal business strategies. What has to be shown economically is that welfare is reduced by employing a certain strategy.

Because welfare is not easily measurable, in particular since long run effects have to be taken into account as well, welfare does not necessarily yield a practical legal tool to distinguish anti-competitive practices from normal business strategies.29 We will come back to this question when discussing various anti-competitive practices.

3.2.1 Strategies aimed at deterring entry

Firms can abuse a dominant position (or indeed create a dominant position) by deterring entry. While the analysis of entry barriers is crucial for understanding the effectiveness and persistence of market power, it is not so easy to isolate entry deterring strategies as a single source of abuse. Many types of abuse, such as predation, are based on the notion that future entry is discouraged. In fact, it is often a condition to make abusive strategies profitable. Eliminating a potential entrant or a rival today is of no use if there will be a fresh rival tomorrow. Still, there are some examples of (strategic) entry deterrence that can constitute an abuse by itself.

Strategic entry barriers. Strategic entry barriers are defined as incumbency actions that are designed to influence the behavior of potential rivals. They are effective if potential rivals condsider current strategies as indications of future market conditions (see Gilbert, 1989). Examples of strategic entry barriers are stra-tegic output expansion, preemptive innovation, shelving, excessive investment in advertising, R&D or prod-uct differentiation. These actions have in common that firms need to have market power to make it an effec-tive strategy. How does such a strategy work? Take the example of shelving. It can pay off for a dominant firm to wait with the introduction of an innovation and "milk" its cash-generating established product, until entry is an immediate threat. The dominant firm has to be prepared to counter innovative entry immediately

29 _{This difficulty even frustrated a Nobel price laureate: "Ronald [Coase] said he had gotten tired}

as it takes place, that is, it has to have the innovation "on the shelve". If entry indeed occurs, he puts his new product on the market to take away demand from the entrant.

This strategy is in its effect similar to predatory pricing. Canoy and de Bijl (2000) provide an example in the Dutch consumer magazines market.30 New magazines are often targeted at creating a new market segment. The launch can therefore be seen as an attempt to differentiate products. For a dominant firm, launching a new magazine can be less attractive if, in the face of stagnant advertising budgets and consumer demand for magazines, it dilutes its circulation and advertising revenues. However, if a new firm enters the market with a "new format" magazine, it may be rational for the established publisher to bring a similar magazine to the market and drive the rival out of the market.

In contrast to predatory pricing, "predatory product imitation" need not be based on charging a price that is lower than, in the extreme, the entrant’s marginal cost. It is sufficient to launch the imitating and thus substi-tuting product, charge the same price, and steal away demand from the new entrant to make entry unprofit-able. In addition, there is also a long-run effect. The publisher can build a reputation for retaliating when-ever an entrant attempts to establish a new magazine. The threat of retaliation may discourage potential fu-ture entrants.

As said above, it is quite rare to prove abuse of a dominant position without actual harming a rival. In Berkey Photo vs. Eastman Kodak (1979)31 the monopolist’s failure to disclose information about a new product was seen as anti-competitive.32 It is however, far from easy to prove a convincing case. However,

down they said it was predatory pricing, and when they stayed the same they said it was tacit collu-sion." William Landes in Kitch (1983, p 193).

30 _{See also Hakfoort and Weigand (2003).}

31 _{603 F.2d 263 (2nd Cir. 1979)}

32 _{The court returned to the rule of reason by holding that monopoly is not per se illegal; rather,}

some practices are easier to use to deter entry than to harm rivals. Rivals have invested in sunk costs and are less likely to divert assets to other areas (or even exit the market) than potential entrants. It follows that one is expected to find lots of possibilities of anti-competitive entry deterrence. Whether this also implies lots of legal cases is a different matter. Potential entrants have very bad track records as plaintiffs. "Most are denied standing. The practices are also generally subtle and hard to identify, and the public enforcement agencies are generally reluctant to spend vast amounts of money in litigating them." (Hovenkamp, 1999, p. 281).

Another example from the economic literature is "banked advertising", i.e. firms engage in (large amounts of) advertising to scare off entrants (Pepsi and Coke comes to mind). In practice, it turns out to be virtually impossible to distinguish anti-competitive advertising from normal advertising practices. This problem is endemic to strategic entry barriers and also holds for other types of strategies, such as strategic product dif-ferentiation.

Concluding, while there seem to be ample possibilities for anti-competitive entry deterring strategies, filing suits against them as a single source of abuse is problematic.

3.2.2 Strategies aimed at forcing the exit of a rival

There are two main types of forcing a rival out, predation and foreclosure. Other varieties such as price dis-crimination can best be grouped under predation, since disdis-crimination is only anti-competitive if it is preda-tory in nature. Both on predation and foreclosure there is a bulky literature which we will not repeat here. Instead, we will point at some new developments in both areas.

Predation. The historical case on predatory pricing is Standard Oil (1911, 221 US 1), which attained a 90% market share in part through price warfare. While the Standard Oil case poked up the debate on pre-dation, and many predation cases were won between 1940 and 1975, the debate was considerably cooled down after the publication of the Areeda and Turner (1975) article. The article which suggested a standard check on predation based on average variable costs, made so much impression on judges that plaintiffs have virtually been empty-handed ever since. Combined with the Areeda-Turner logic there have been two other developments, one economic and one legal. The economic development is the Chicago School logic which argued "forcefully" that predation was not rational and therefore it did not make sense to make a lot of fuzz about it. The notion of irrationality of predation remains the dominant legal paradigm in the US until today. The legal development was the famous Brooke case in 1993 (Brooke Group vs. Brown&Williamson To-bacco Corporation, 509 US 209), which boiled down to a heavier burden of proof on the part of the plaintiff, because – unlike the earlier days of predation – the Supreme Court upheld the lower courts view that the plaintiff had to show that recoupment of predation losses was sufficiently likely.

As forwarded by Bolton, Brodley and Riordan (2000), economic theory has moved considerably beyond the simplistic irrationality paradigm and also provides new strategic recoupment possibilities neglected in ear-lier economic theory. These new insights – if adopted by the judges as the current state of the art – could very well lead to a renewed interest in the subject.

mass for a new or renewed product. On the other hand, low prices can also be the result from an attempt by the incumbent to force a rival out of the market. The incumbent opts for a short-term loss in order to make long-term extra profits thanks to a dominant position.

Predatory pricing implies that there is a price reduction which is profitable only because of the added market power the predator gains from eliminating, disciplining or otherwise inhibiting the competitive conduct of a rival or potential rival. In the short term customers may benefit from lower prices, but over a longer period weakened competition will lead to higher prices, lower quality or less choice. The fact that an activity is being run at a loss, is not sufficient to establish a case of predatory pricing. The question is whether it has an anti-competitive effect. In order to prove the anti-competitive effect of predatory pricing, Bolton et al. (2000) propose a five-criteria rule:

1. a facilitating market structure,

2. a scheme of predation and supporting evidence,

3. probable recoupment,

4. price below cost and

5. the absence of efficiencies or business justification defense.

Subnote 1) The market structure must make predation a feasible strategy. A company must have the power to raise prices (or to otherwise exploit consumers or suppliers) over some significant period of time (dominant firm or small group of jointly acting firms, entry and re-entry barriers).

applied game theory can help to identify economic conditions under which predation is rational profit-seeking conduct by a dominant firm. Ex post probability is shown by the subsequent exclusion of rivals and post-predation market conditions that make future recoupment likely.

Subnote 3) At the very least, the losses incurred from a predation strategy must be recouped some-how. Should the operator be unable to recoup the losses, because of competition from existing or potential competitors, the predation strategy is not viable. Recoupment is only possible if there is an exclusionary effect on (potential) rivals, or through the disciplining of the rival’s competitive conduct. The most common and straightforward recoupment occurs when prices in the predatory market rise above the competitive level. In more complex settings, recoupment can occur through other channels, e.g., by raising the prices of com-plementary or closely-related services. It is essential that these latter price increases should unambiguously be explained by the earlier predatory pricing (see also Cabral and Riordan, 1997).

Subnote 4) In the predatory period, prices should be below average variable cost, although also prices which are also above average variable cost but below average total cost might be predatory and injure competition. The most used cost standards are average total cost (ATC) and average variable cost (AVC) or long-run average incremental cost (LRAIC) as a substitute for ATC and average avoidable cost as a substi-tute for AVC (Bolton et al., 2000). If prices are above ATC, there is no problem. If prices are below AVC, predation can be assumed. A price between ATC and AVC is either presumptively or conclusively legal. If the price is presumptively legal, there is a need for evidence that the operator intends to eliminate or to dis-cipline a competitor.

The five-criteria rule provides a clear procedure how to handle a potential predatory pricing case. However, predatory pricing might be hard to prove, particularly the recoupment aspect. Bolton et al. (2000) provide new economic underpinning for predation to be rational and to distinguish it form normal business practices. To sort out the differences between the two they suggest to check whether there are indeed plausible ciency gains as a result of the below cost pricing, whether there are alternative means to achieve those effi-ciency gains and whether the effieffi-ciency gains are materialized in e.g. higher quality (instead of just higher profits).

Bolton et al. (2000) then continue to develop plausible ways in which predation can occur, using new in-sights from economic theory. We mention two examples.

Financial predation. The argument here depends on capital market imperfections. Investors faced with moral hazard and selection problems, tend to favor large firms at the expense of smaller ones. This in-cumbency advantage can be exploited. When start-ups need cash flow to pay back their debts, predators may have an easy target. Cutting prices reduce cash flow and the capital market imperfection stimulates predation. Bolton et al. (2000) show how financial predation could be used in a recent cable TV case in Sacramento.

Signaling and reputation. The predator can also lower its price in order to mislead the prey into believ-ing that market conditions are unfavorable. The incumbent exploits its superior knowledge on cost and demand to deter entry or eliminate a rival. Bolton et al. illustrate this possibility by the old Bell case (1879).

criticize Bolton et al. for being too simplistic and too model specific. Without going into the details of this discussion (there was also a lengthy reply by Bolton et al.), we conclude the following:

Predation can be rational in a variety of settings, and more than previously assumed (in particular by US courts), mostly hinging on incomplete information arguments.

It is not clear how serious predation is in practice. Ultimately, this is an empirical question.

Applying the five step procedure by Bolton et al. seems a sensible thing to do, no matter how strong one feels about the applicability of economic theory or the empirical relevance of predation strategies.

When we look at the European practice, we observe a difference in views again. The US law on predatory pricing has been reasonably clear at least since the Brooke Group v. Brown & Williamson case in 1993. There the Court held that to be found predatory, conduct must satisfy a two-part test: (i) the allegedly preda-tory price must be below an appropriate measure of cost, and (ii) there must be a “dangerous probability” that the alleged predator will be able to recoup its losses through monopoly prices once its rivals exit the market. The European Court of Justice (ECJ) has adopted the first part of the Brooke Group test, but has declined to adopt the second part, holding that recoupment is not a necessary element of predation under Article 82 EU Treaty.33 Recoupment seems an essential element of the test because cutting prices in order to increase business often is the very essence of competition."34

The marked difference in approaches between the U.S and the EU again reflects differences in the view on treating behavior of powerful firms (see further section 5). In addition to the recoupment debate there is a second difference. Whereas most US courts have held that the appropriate measure of cost is average

33 _{See Tetra Pak Rausing SA v. Comm’n, Case C-333/94P, [1996] ECR I-5951.}